The Cost of Corruption to Latin America’s Competitiveness

The Cost of Corruption to Latin America’s Competitiveness

 

The World Bank identifies corruption as the single greatest obstacle to economic and social development. And, indeed, the prevalence of corruption is strongly correlated with a country’s overall competitiveness. The World Economic Forum estimates that bribe payments amount to over $1 trillion annually, with Latin American countries being among the most corrupt.1

Meanwhile, the region is struggling in regard to its global competitiveness: Mexico and Brazil, the region’s two biggest economies, both saw their competitiveness stagnate from 2009 to 2011, while China became more competitive during the same period.2

Countries that have tackled corruption have reaped enormous benefits: by some estimates, reducing corruption can increase per capita income by up to 400 percent.3 That said, addressing the scourge of corruption entails fundamental changes to how the public sector operates—and to ingrained attitudes and mentalities. This requires dedicated commitment and much political will. But with corruption so instilled in the Latin American culture, who is up for the challenge?

Corruption as a modus operandi

Historically, Latin American countries were characterized by having weak democratic institutions and authoritative governments, the perfect combination for the spread of corruption. While this has been gradually changing all across the region during the past three decades, the phenomenon remains entrenched deep within the roots of society, proving difficult to eradicate.

Indeed, Transparency International’s annual Corruption Perceptions Index (CPI) shows that in 2011 most Latin American countries (with the notable exceptions of Chile and Uruguay) are still subject to endemic corruption. Despite recent government attempts to tackle corruption, Brazil and Mexico still only obtained lowly scores of 3.8 and 3.0, respectively (whereas the region’s outliers, Chile and Uruguay, scored 7.2 and 7.0).4

Sadly, bribery of public officials, kickbacks in public procurement and embezzlement of public funds are still all too prevalent throughout Latin America, to the point that such practices constitute an unspoken modus operandi for doing business in the region. A case in point are the recent revelations, first published by the New York Times, of Wal-Mart’s systematic bribery of Mexican officials to the tune of US$ 24 million over a 9-year period.5 The giant retailer’s Mexican business unit had set up an elaborate scheme to systematically offer bribes and facilitation payments for accelerating necessary zoning permits and getting store construction underway ahead of its competitors. That the case came to light at all is exceptional and it speaks to the prevailing expectations and, indeed, the culture of corruption in the region’s business dealings. Some sectors are more prone to corruption than others: AMI estimates, for instance, that the average corruption level on infrastructure projects ranges from 15% to 25% of project value, and up to 30% in the region’s most corrupt countries.

The adverse effects of corruption

The effects of corruption run deep. Countries with high levels of corruption experience lower acceptance of established institutions, deficient court systems, political instability, and heightened income inequality. Corruption also lowers the quality of public infrastructure and expenditures on education and health. Furthermore, there is a direct correlation between corruption, the growth of the informal economy, and the spread of illicit activity in the form of organized crime and illegal cartels, among others. Sadly, all of these attributes are all too often characteristic of many Latin American countries and they all contribute to eroding competitiveness in the global economy.

Empirical data demonstrates this direct correlation between corruption and competitiveness (see Exhibit 3). The reduction of a country’s corruption level increases its overall economic performance, most notably with an increase in foreign direct investment. Estimates show that a 1-point improvement in a country’s CPI ranking has an economic impact equivalent to a 7.5% general tax increase. Similarly, a 1-point deterioration reduces GDP growth by an estimated 0.13% and GDP per capita by US$ 425.6

As a result, many countries in the region are not in a position to reap the full benefits of modern, well-run economies, whose value-added increasingly comes from private sector innovation. As long as private sector companies bear a heavy cost due to corruption, their incentives to invest in research and development or high-risk innovative ventures will remain limited.

According to the World Economic Forum, economies can be categorized into three stages: factor driven, efficiency driven, and innovation driven. Generally speaking, developing economies are still in the first phase, fast-developing, emerging economies are categorized in the second, and developed economies are in the third. Latin America and China both currently considered Transition 2-3 economies (meaning they are focused on boosting higher education and training; reaping efficiencies in product markets, the labor market, and the financial sector; and improving their technological readiness—all with the goal of acceding to the third stage, where the focus shifts to increasing business sophistication and innovation). However, it is difficult to conceive of a country that can adequately transition to an innovation-based economy when it is saddled with high levels of corruption. Worse, when corruption is endemic, it’s not just a country’s potential that is at stake, but its actual economic growth: the high levels of corruption seen in most of the region’s economies are inhibiting future growth.

What can be done to reduce corruption moving forward?

The World Economic Forum’s annual Global Competitiveness Report ranks how competitive countries are relative to each other based on a broad set of institutions, policies, and other factors, some of which have a bearing the prevalence of corruption in the public sector. One of the reasons China’s economy’s is more competitive than either Brazil’s or Mexico’s—despite comparable levels of corruption (China scored a 3.6 on Transparency International’s CPI index, putting it on equal footing in this regard)—is that it has achieved more progress on key institutional and policy dimensions (among others in the quality of public education, macroeconomic stability, innovation capacity, etc.). In the case of Latin America’s biggest economies, the World Economic Forum’s recent findings suggest that the reforms with the potential for the greatest reduction in corruption levels would be boosting domestic competition7 and, in the case of Mexico, also tackling the chronic weakness of the country’s public institutional framework.8 These nevertheless represent significant reforms, which require political will and legislative consensus—both of which are currently in short supply.

There are only a few examples of once hopelessly corrupt states that have succeeded in turning themselves around. They nevertheless provide a useful model to emulate. Hong Kong is just one such example: until 1974, the city was one of the most corrupt in the world. Corruption was a way of life and people had come to accept it as normal, as is the case in many Latin American countries today. The main action the Hong Kong government took to eradicate the problem was the creation of an independent body to clean up endemic corruption. The new anti-corruption agency focused on investigation, prevention, and community education. Crucially, the fight against corruption coincided with a period of significant economic growth. Hong Kong’s experience suggests several applicable lessons:

  • It is imperative for political leaders to demonstrate genuine commitment to the eradication of corruption; otherwise, however well designed, all efforts will be futile.
  • Incremental or piecemeal measures will not suffice: an effective anti-corruption strategy requires a comprehensive set of anti-corruption measures, including passage of tough anti-corruption laws, their consistent enforcement, and the establishment of an independent watchdog.
  • An effective anti-corruption agency with a strong mandate to act is absolutely essential to successfully tackle corruption in the public sector. To be viable and effective, such an agency must be credible, well funded, autonomous, and above the political fray. Above all, it must be created separately from any police functions or law enforcement agencies.
  • Critical to the anti-corruption agency’s success is the appointment of a well-respected leader with broad support across the political spectrum, stellar credentials, and an impeccable reputation for honesty and integrity.
  • To change the prevailing incentives that allow corruption to take hold among civil servants and public officials, public sector salaries and fringe benefits need to become competitive with those in the private sector.

Making up for lost ground and staying competitive globally

If Latin America wants to stay competitive, the region must tackle its endemic corruption problem. China has already surpassed the largest Latin American economies in terms of competitiveness, though it too also has a long way to go to eradicate public sector corruption. That said, Latin American countries may not be able to afford waiting for the implementation of necessary structural and institutional reforms, which are complex, politically sensitive, and time consuming. To mitigate the adverse effects of corruption, boldly tackling it head on may be the best option for the region’s countries to stay competitive in the global marketplace.




Guillaume Corpart is the Managing Director of Americas Market Intelligence and a veteran of Latin American competitive intelligence and strategy consulting.


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Notes
1 Transparency International Organization, Bribe Payers Index 2011, http://bpi.transparency.org/results/ 
2 World Economic Forum, The Global Competitiveness Index 2011-2012, http://reports.weforum.org/global-competitiveness-2011-2012/
3 Axel Dreher, et al., “How do Institutions Affect Corruption and the Shadow Economy,” University of Exeter Discussion Paper, February 2005.
4 The Index ranks countries based on the perceived levels of public sector corruption on a scale of 0 to 10, where 0 indicates a highly corrupt public sector and 10 a very clean government. See Transparency International, Corruption Perception Index 2011, http://cpi.transparency.org/cpi2011/results/
5 David Barstow, “Wal-Mart Hushed Up Vast Mexico Bribery Case After Top-Level Struggle,“ The New York Times, 21 April 2012, http://www.nytimes.com/2012/04/22/business/at-wal-mart-in-mexico-a-bribe-inquiry-silenced.html?_r=1&emc=na
6 Axel Dreher and Thomas Herzfeld, “The Economic Costs of Corruption: A Survey and New Evidence,” June 2005.
7 For more on the lack of competition in Mexico’s domestic market, see AMI, Addressing Mexico’s persistent inequality by tackling entrenched monopolies, April 2012, http://americasmi.com/en_US/expertise/articles-trends/page/mexicos-inequality-and-its-monopolies
8 World Economic Forum, The Global Competitiveness Index 2011-2012, http://www3.weforum.org/docs/WEF_GCR_CountryProfilHighlights_2011-12.pdf 

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